Bitcoin (BTC) investors are facing six daily red candles this week, accompanied by a broad market sell-off following further concerns over the Federal Reserve's hardline policies.
Following the release of the December Fed Open Market Committee meeting, markets reacted to notes related to an accelerated pace of tapering, interest rate hikes and possible quantitative tightening to lighten the central bank's balance sheet.
After starting at $47,875, bitcoin experienced global declines, trading down 15% for the year. Since then, prices have finished the first full week of 2022 at $40,672, putting the “bulls” on the defensive at the start of the year.
In this week's newsletter, Glassnode will present a number of fundamental concepts about how market participants react, including:
– the climate of spending old coins on the blockchain;
– increasing levels of Open Positions in futures markets;
– the potential for a “short squeeze” to develop (when the price rises too fast) as low prices are negotiated and pessimistic conviction drives the market down.
Saved by Bitcoin HODLers
A phase of strong loss-making by large buyers followed the December 4 sell-off, as reported in December .
Since then, blockchain behavior has been largely dominated by the class of HODLers, with little activity from new market entrants.
One way to check this dynamic is through the Hodlers Net Position Change, which is the 30-day moving change in currency maturation.
As units of BTC “age” and mature in investors' portfolios, they accumulate “Currency Days”, which are “destroyed” in spend and help to produce various lifetime metrics.
– Positive values (green color) means coins are aging and maturing at a faster rate than they are being spent. This usually happens during negative market conditions, with no retail interest, as long-term accumulation occurs by high conviction buyers.
– Negative values (red color) occur when high spending rates, especially for older coins, exceed the current behavior of accumulation. This is often seen at the height of bull markets and moments of total capitulation, when holders are more likely to give up their allocations.
After a brief period of net spending after the price spike in November, the ripening took place again amid the price drop.
It is a trend commonly seen when retail/tourist investors exit the market, HODLers remain, and there is generally more pessimism regarding price expectations.
Another method of measuring spend velocity is through the Value of Days Destroyed Multiple (or VDD), which compares the monthly value of the sum of coin destruction to the annual average.
– High values of the Multiple VDD indicate a high behavior of coin destruction related to the previous year. Historically, it marks periods of heightened market liquidity, high turnover in supply and rising prices.
– Low VDD Multiple values demonstrate a quiet HODLer market with relatively calm coin destruction. These moments can extend over long periods and usually occupy cyclical lows.
Using the activity VDD perspective, the bullish cycles in October and November saw a very light level of spending compared to the long-term average.
This was to some extent influenced by the historically high values of VDD reached in early 2021, but still shows that the spending value at the recent record high was relatively low.
This again presents the picture of a market dominated by HODLers and low interest relative to retail.
Rounding out the assessment of spending behavior is the Entity-Adjusted Dormancy Flow, which compares bitcoin's market capitalization (the asset value) to the annualized dollar value of currency Dormancy (spend reason).
Dormancy is the average age (in days) of coins spent per unit of BTC, similar to the volume-weighted Average Lifetime of Spend.
– High values in the Dormancy Flow mean that the value of the network is high relative to the annual value of Dormancy realized in dollars. The interpretation is that the bull market is in “healthy” conditions (spending in line with the demand assessment).
– Low values in the Dormancy Flow indicate times when the market capitalization is undervalued in relation to the annual sum of realized Dormancy, indicating times when bitcoin is valued.
Entity-Adjusted Dormancy Flow hit recent bottoms, demonstrating a complete redefinition of the metric.
Historically, these events happen in cyclical funds and the confluence with the Hodlers Net Position Change and the VDD Multiple suggest a possible short-term spending fund, barring new surprises.
Thanks to the three charts above, it is possible to identify market conditions often seen in the final stages of a macro downtrend, usually around capitulation events.
It remains to be seen if there will be further downward suffering, perhaps in response to the macro/monetary turmoil or if most of the damage has passed and a positive relief cycle is on the way.
Futures markets with new highs in Open Positions
While blockchain activity has calmed down, leverage in the bitcoin derivatives market is growing at an aggressive pace.
This refers to an outsized interest in bitcoin price action as a speculative gamble rather than the relatively lukewarm demand for bitcoin on spot markets.
Leading the valuation of derivatives is the growth of Open Positions in Perpetual Futures, which is the sum value of all open contracts in the futures markets.
Shown here in bitcoin terms, Open Positions in Perpetuals hit new record highs of 264K BTC amid recent price drops, up 42% since Dec 4 and surpassing the previous high of 258K BTC on Nov 26.
As first principles understand that price drops will inherently drive traders out of long positions, an increase in Open Positions in recent days suggests that short traders are placing bets on the weakening market.
Leading the rapid growth of futures speculation are users of Binance , the largest bitcoin futures exchange in terms of volume and size.
Since May 2021, Binance has taken advantage of the most Open Futures Positions among all exchanges, with a notable increase in market share during recent weeks.
Since a drastic drop on December 4, Binance has absorbed 9.4% of Bitcoin Futures Open Positions and now dominates 30% of the market .
The second largest broker by market share in Open Positions is FTX , with 19%, surpassing Bolsa Mercantil de Chicado (or CME).
CME enjoyed a surge in market dominance in October with the launch of the BITO index fund (or ETF), but is now the third largest with 15% of Open Futures Positions.
The drastic spike in Open Futures Positions can be analyzed in another way: it is represented as a ratio of leverage against Market Capitalization.
Generally, periods when Open Futures Positions exceed a volume greater than or equal to 2% of Market Cap are brief and tend to end up with a drastic margin flush.
Deleveraging events can happen in both directions and sometimes happen despite a leverage ratio in Open Positions below 2%, such as on September 7, when El Salvador made bitcoin its currency.
The combination of high Open Positions with a big event generated a volatile fall.
However, each time leverage exceeded 2% in the last year it ended with a quick settlement of contracts. At this time, the Futures Open Position Leverage Ratio is at 1.98% , so there is a non-trivial risk of high short-term volatility.
Short-term squeeze for short positions
A by-product of consistent price declines is the liquidation of confident long position traders trying to profit during the downturn.
A great way to visualize the trend of liquidations is through the dominance oscillator between liquidations of buy and sell positions.
Since November, bitcoin futures have been in a long liquidation dominance regime, where traders who bet that “the number will go up” are always on the losing side.
This figure has recently skyrocketed to a local high of 69%, its highest since the May 2021 dip .
When considering the observation of the aforementioned high of Open Positions at decreasing price, the probability of a local reversal is increasing. Short-position traders, who have not been punished for taking more risk, may experience a short-term squeeze.
As the volume of open futures positions increases to new highs, the trend of the daily sum of futures trading volume is going in the opposite direction.
Large price movements result in contracts being traded and “stop-losses” being activated.
In sideways price action, traders get away with not having to close their positions, allowing volumes to drop in periods of consolidation while Open Positions can remain high.
Futures Volume peaked in the first half of 2021, where daily trading exceeded $75 billion for weeks. After the market plunged 50% in July, record highs in October were supported by volume of around $65 billion daily.
However, in the current environment, the 14-day average Daily Futures Volume is around $38 billion/day, the same level during the July dips.
Low trading volumes can create environments of reduced market deepening and limited resistance against rapid price moves.
Should a deleveraging event occur, in an environment of low liquidity, the magnitude of the price movement will be greatly amplified.
To complement the analysis of derivatives, the Open Positions of Options are checked.
In December, all attention was focused on the decline on December 31, after months of accumulating more than $11 billion in contracts. Many of these contracts were dominated by “bulls”, with particular emphasis on bitcoin prices exceeding $100,000.
On January 1st, Open Options Positions fell to $6.2 billion from a value of $11.2 billion recorded on December 31, a decrease of 45% ($5 billion).
The year-end drop was the biggest during 2021 in percentage closes, but only second in dollar totals. The March 26 drop saw a record $5.3 billion expired, down 36%.
In summary, bitcoin's current market structure can best be described as having:
– a lukewarm demand for “spot” , as most blockchain metrics describe a dominance of HODLers in accumulation, something typical in bear markets with little retail/tourist interest;
– Derivatives market leverage is at high risk levels of around 2% of market capitalization. It is largely driven by the Binance markets and open positions have increased as prices fall.
– There is a high risk of deleveraging, along with low trading volumes and a high probability of dominance of short positions in futures markets.
Along with indicators of high oversold in blockchain spending activity, it suggests a likely short-term resolution of a “short squeeze” for the market. Overcoming macro turmoil and re-establishing a compelling uptrend will be a focus of future newsletters.
About the author
Glassnode is the largest blockchain intelligence and data provider that generates on-chain metrics and tools for anyone who really wants to understand the cryptocurrency market.
*Translated and edited by Daniela Pereira do Nascimento with permission from Glassnode.
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